CPA Exam - FAR (Financial Accounting and Reporting)Select TransactionsHard
A company, a U.S. parent, has a subsidiary in a foreign country. The subsidiary's functional currency is the local currency, which is highly inflationary. Which method should the U.S. parent use to translate the subsidiary's financial statements?
- ATemporal method
- BHistorical rate method
- CWeighted-average method
- DCurrent rate method
Show answer & explanationAnswer & explanation
Correct answer: A. Temporal method
When a foreign subsidiary's functional currency is highly inflationary (typically defined as cumulative inflation of 100% or more over a three-year period), U.S. GAAP (ASC 830) requires that the financial statements of that subsidiary be remeasured as if the U.S. dollar were its functional currency. This remeasurement process is known as the temporal method (or remeasurement method).
Why the other options are wrong
- B. The historical rate method is generally used for non-monetary items under the temporal method, but it's not the overall method.
- C. The weighted-average method is used for income statement items under the current rate method, but it's not the primary translation method for highly inflationary economies.
- D. The current rate method is used when the local currency is the functional currency and is not highly inflationary.
Foreign Currency Translation - Highly Inflationary Economy
When a foreign subsidiary operates in a highly inflationary economy, its financial statements must be remeasured into the parent's currency (U.S. dollar) using the temporal method.
- Highly inflationary: cumulative inflation >= 100% over 3 years.
- Functional currency is deemed to be the parent's currency (USD).
- Uses the temporal method (remeasurement).
- Remeasurement gains/losses are recognized in net income.
Memory trick: Inflation's too high, temporal's the way, otherwise current rates save the day.